Western Interest in Islamic Finance Increasing

by Anne Szustek
Amid the economic downturn, the principles of Islamic finance are getting more attention from several quarters, including the Catholic Church.Islamic Bonds May Be Issued for 2012 Olympics
This week, the Vatican’s newspaper published an article encouraging western banks to adopt Islamic finance principles.

“The ethical principles on which Islamic finance is based may bring banks closer to their clients and to the true spirit which should mark every financial service,” wrote Loretta Napoleoni, an author, and Claudia Segre, a fixed income specialist, according to Bloomberg.

Last week, London’s mayor said the city may issue sukuk, or Islamic bonds, to help pay for the 2012 Olympic games. Lord Mayor Ian Luder said that “there must be an agreed world standard for Islamic finance products for the market to meet its potential,” according to Gulf News.

Nearly two dozen banks in London already offer Sharia financial products, which Gulf News says is “an indication of the growing importance” of it in the United Kingdom’s financial industry.

Indonesia also experienced recent success with a sukuk. Last month, it issued the country’s first retail bond compliant with Sharia. Officials had hoped to raise 1.7 trillion rupiah, but it instead raised 5.56 trillion rupiah.

“The government is turning to Islamic financing in order to take advantage of demand for Islamic-compliant products in the world’s most populous Muslim nation,” Reuters reported.

Background: Islamic Finance More Insulated From Downturn
Investment vehicles that adhere to sharia, or Islamic law, have been largely unscathed by much of the global credit crunch, thanks to religious beliefs stipulating that money lent must be backed by collateral. This simple rule curbed Islamic financial units from buying collateralized debt obligations, the repackaged investments of securities now known largely as “toxic debt.”

In Islam, there is a ban on assessing interest; according to BusinessWeek, “the Prophet Mohammed said debts must be repaid in the amount that was loaned.” While Islamic financial securities not been completely immune to the world credit crunch, they’ve kept out of the toxic debt market.

“This is one way to keep both feet on the ground,” Rozali bin Mohamed Ali, the head of an Islamic finance university in the Malaysian capital of Kuala Lumpur, told BusinessWeek.

What may be Islamic finance’s Achilles heel is real estate, which has held up fairly well so far in the oil states of the Persian Gulf, home to many major sharia-compliant banks. Real estate is often used as a form of collateral for Islamic financial institutions. Dubai Islamic Bank (DIB) is at particular risk, given that two of its former executives were allegedly involved in a real estate scandal and 30 percent of the bank’s assets are in property. However, the bank’s CFO, Mohamed Al-Sharif, maintains that DIB is largely protected, as “we only go after prime locations,” he was quoted as saying by BusinessWeek.

Still, the market on “sukuks,” or Islamic bonds, has fallen by 31 percent, compared to its four-fold growth from 2004 to 2007. But bank Standard Chartered remains optimistic on the medium to long-term outlook for sukuks. “People are waiting for right levels of price to launch but nothing has happened to the sukuk (Islamic bonds) market fundamentally,” Standard Chartered’s worldwide Islamic banking head, Afaq Khan, told Reuters.
Context: Islamic finance; Gulf economy
Sources in this Story
Bloomberg: Vatican Says Islamic Finance May Help Western Banks in Crisis
Gulfnews: UK working to offer sukuk in sterling
Reuters: UPDATE 2-Indonesia raises more than forecast in retail sukuk
BusinessWeek: Islamic Finance May Be On to Something
Reuters: Interview: StanChart sees sukuk market weathering tough times
Investopedia: Working With Islamic Finance
findingDulcinea: Persian Gulf Feeling Pinch of Credit Crunch, Falling Oil Prices
findingDulcinea: The Chips Are Down for the Gambling Sector
Marketwire: Christian Brothers Investment Services Withdraws Shareholder Resolution as Cisco Discusses Giving Investors an Advisory Vote on Executive Pay
Under sharia, interest or “riba” is considered “haram” or forbidden, as it entails lenders making money from money. Sharia-compliant banking has thus devised elaborate ways to develop a profitable financial sector that abides by Islamic principles.

To get around the prohibition on interest, Islamic banks employ profit-and-loss sharing contracts, known as “mudarabah” in which the investor and lender pool assets, as well as “musharakah,” in which the bank purchases the item which the consumer intends to buy and effectively sells it back in installments to the one who needs the loan. An Islamic bond or sukuk operates largely along the same lines as mudarabah deals.

“Ijarah” is an Islamic leasing transaction that allows residents to use a given item for a set period of time. This often comes into use in real estate transactions in the United Arab Emirates, where non-citizens are not allowed to own real estate outright.

Sharia-compliant funds do not invest in pork, pornography, alcohol or gambling, and some Muslims regard insurance as a form of gambling. A form of profit-sharing called “takaful” has emerged to fill this niche, into which policy subscribers pay into a pool that is withdrawn as the need arises.

Proponents of Islamic finance argue that it offers more stable financial mechanisms than does conventional banking, as it forces banks to make longer-term projections when considering financial courses of action. Increasing numbers of non-Muslims have made sharia-compliant investments for similar reasons. BusinessWeek reports that at Amana Funds, Saturna Capital’s sharia-compliant unit, some two-thirds of new money is from non-Muslims. Monem Salam, the director of Islamic investing at the Bellingham, Wash.-based bank, told BusinessWeek, “People are trying to hide from leverage by investing in our funds. But when leverage gets acceptable again, they will go somewhere else.”

A potential outpouring of funds is also threatening the economies of the Gulf, where Islamic banks are popular. Much of the Gulf states’ wealth, based largely on oil, is being sapped by falling prices, and the region’s real estate boom is being crimped by tightened lending.
FindingDulcinea’s Islam Web Guide provides an outline of the faith, including background information, links to online interpretations of holy texts, directories of mosques and calculators for local prayer times.
Related Topic: ‘Sin sector’ stocks; ‘socially responsible investing’
Historically, “sin sector” stocks such as alcohol, gambling and tobacco—which are necessarily excluded from sharia-compliant investment funds—have been a safe bet in bearish financial markets. However, by and large this year, these stocks have slumped.

Islam is not the only religion to promote “socially responsible investing.” There are Christian-based investment funds available to interested parties. Christian Brothers Investment Services, a Catholic investment index, withdrew a shareholder request on Cisco Systems’ executive compensation after the tech company agreed to disclose its “Say on Pay” policies.

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